In a past life, I worked for a tech startup. I’ll never forget waiting on pins and needles while our fearless CEO met with prominent investors and big-name venture capital firms.
First came the seed funding. Then Series A. Series B. And so on.
It was a roller coaster—nerve-racking, but exciting too. When the funds came in, we renewed our excitement, mapped out goals, and plunged ahead as we “disrupted the industry.”
I can’t help wondering, though … what if we had secured a loan instead? Did we take the right approach by seeking investors?
In our case, I think we did. We needed significant funds to staff a 30-person team. But is getting an investor always the right approach? When should you take out a small business loan instead?
The truth is, it depends on your business and goals. Here’s how to know which approach you should take.
When Investors are Best
Investors give you the initial funding you need to start your small business and grow—in exchange for a percentage of ownership in the company. Typically, investors ask for shares and want to be kept abreast of the company’s direction and progress. In addition, most venture capitalists want a seat on your company’s board of directors.
Depending on the stage of your company, there are a couple of different types of investments:
Seed funds: These are the first funds you need to start your business. They can come from anyone you know—your mom, grandmother, or a friend. Typically, it’s just enough to get you started, but it won’t be enough to get you all the way.
You can secure seed funds through supportive family members and friends, a crowdfunding campaign (try Kickstarter or GoFundMe), or by seeking experts at startup incubators or accelerators. These are office spaces that also provide community and guidance to startup entrepreneurs.
Early-stage funds: Once you’ve nailed down a bit of cash, you can continue to seek funds from current investors or new investors. You’ll need to be prepared with your pitch, though. At this stage, investors want to see an excellent pitch deck that maps out your business model and the opportunity for growth. They want to see some progress and maybe even your first hire. Essentially, they want to feel confident in their investment.
Most seed and early-stage funds come from angel investors, but sometimes they come from venture capitalist firms. Angel investors work alone and usually invest less money than venture capital firms, which are made up of a group of professional investors. Venture capital firms invest in companies at any stage—but always in high-growth companies.
Now, before you seek an investor, it’s important to know the pros and cons of doing so.
The “pros” of investors
There are a lot of benefits of working with an investor. After all, it’s a great way to get started:
- Funds can come in quickly—even overnight.
- You might be able to obtain future funding from a current investor.
- You can get funding just by selling a promising idea. You don’t necessarily have to have a product that’s ready for market.
- Investors can provide guidance and direction to your company.
The “cons” of investors
But investments don’t come “free.” There’s a cost involved, and that cost usually comes in the form of ownership:
- Investors offer funds in exchange for a percentage of your company. Usually this means shares—and less cash for you and your team.
- Often they want to weigh in on the company’s direction. After all, they have a stake in the game. Most venture capitalists will also want a seat on your board.
- If you sell your company, you’ll need to pay a percentage back to investors.
When business loans work better
There is another option—a small business loan. In this scenario, a lender matches you with the right loan for your business. Then you pay back the loan, along with interest, over a period of time.
Just like startup funding, there are several different types of small business loans available. The type you want depends on your business and its goals:
Term loans: You get cash right away and then pay back the loan over a period of time.
Business line of credit: You get funds up to your credit limit. Then you pay back the funds that you withdrew. Like a credit card.
Equipment loans: The life of the loan is usually equal to the life of the equipment. A lot of small business owners will go this route if they want to own their equipment.
Invoice (accounts receivable) financing: If your business has unpaid invoices and needs funds now, this money will cover what’s owed to you.
Merchant cash advance: In this scenario, you get cash up front and then a financing company takes a percentage of your daily credit card and debit card sales, as well as a fee.
The “pros” of business loans
Many small business owners seek loans first, and it’s easy to see why:
- Repayment plans are usually clear and predictable, especially if you secure a fixed-term business loan.
- You keep ownership in your company, instead of handing it over to investors.
- It’s not as “messy.” After all, you’re still the one making the business’s decisions.
The “cons” of business loans
That said, if your business is new and not yet reeling in revenue, securing a business loan can be hard. That’s why a lot of startups go to investors. And even if your business is making money, lenders will look at your personal credit too. If your personal credit is damaged, you may have trouble securing a loan.
In addition, many loans will include restrictions for how you can use the funds (like equipment loans). And if you default on your payment, you could put your business and personal assets at risk.
But as small business owners, we know that starting a business does include some risk. Whether you choose the risk of pitching to investors or the risk of paying back a loan, there will always be a part of you that’s uneasy. That’s the nature of the game. But, remember, starting your own business is incredibly rewarding and often does pay off.
After all, there’s no reward without some risk.
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